Sunday, June 29, 2008

What Can Onions Teach Us About Oil Prices?

Onions have no futures market, yet their recent price volatility makes the swings in oil and corn look tame.

Fortune Magazine -- Before the government starts scrutinizing the role that speculators may have played in driving up fuel and food prices, investigators may want to take a look at price swings in a commodity not in today's news: onions.

The bulbous root is the only commodity for which futures trading is banned. Back in 1958, onion growers convinced themselves that futures traders were responsible for falling onion prices, so they lobbied an up-and-coming Michigan Congressman named Gerald Ford to push through a law banning all futures trading in onions. The law still stands. And yet even with no traders to blame, the volatility in onion prices makes the swings in oil and corn look tame, reinforcing academics' belief that futures trading diminishes extreme price swings. Since 2006, oil prices have risen 100%, and corn is up 300%. But onion prices soared 400% between October 2006 and April 2007, when weather reduced crops, only to crash 96% by March 2008 on overproduction and then rebound 300% by this past April (see chart above, click to enlarge).

Update: The chart below shows monthly percent changes in the spot prices of onions and oil, from January 2000 to May 2008. The volatility of monthly onion price changes (measured by the standard deviation of price changes, 66%) was7.5 times higher than the volatility of oil price changes (standard deviation of 8.8%) during this period.

The article noted calls out that volatility is not simply a function market speculators. What you continue to miss is that those attacking speculators are NOT applying a theory or logic based in either economics or finance. they are applying a rhetorical argument.

I'm really sorry that you and so many others cannot understand something so simple and fundamental.

Talking about volatility is a straw man. Fortune mixes onions and oils...

Just look at SEC and CFTC records to find out the countless times in the past that speculators have been prosecuting for manipulating prices.

When I was trading bond futures back in the early 90s, several firms were prosecuted for manipulating cash bond prices with the objective of profiting in currency exchange markets.

Then, there is the story of more than 200 Swiss Franc pit traders that were prosecuted for fixing prices of futures in parking lots outside the exchange and thus manipulating the currency value.

I can go on forever. Do you want to know about the Copper market manipulation by Japanese dealers in the mid 90s?

This time is a big one. Sure fundamentals affect price of oil but this is the excuse of the speculators to add a significant premium. I agree price of oil should be higher than in 2005. But the way price moves it is indicative of manipulation.

If you actually read the note you are referring to (or grasped it, which is far less likely) I said a "sort of" inverse quantum effect.

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The problem with your statement above is that you are so utterly sure you have it all right. The people at Fortune are all idiots, and so is Mark, since he can't see the obvious.

Perhaps the real problem is that there is something you THINK obvious which is actually NOT TRUE AT ALL. "Counter-intuitive", remember?

I'll grant you that the fact that "onions are perishables" does appear to have some common-sense relevance to how they are marketed, as well as to how their market behaves.

I would not PRESUME however, to know for sure that the two are real apples-to-oranges when it comes to the market and its behavior.

In other words, the proper way to phrase your absolute statement above is in the form of an interrogative --

"Mark, it seem to me that, since onions are perishable, that this comparison fails to be accurate. It seems to me that the inability to buy and hold invalidates this comparison.

If this is not the case, can you (or anyone) explain to me why?"

This way, you don't sound like someone who knows far more than you so obviously do, and still manage to get the challenge to the reasoning which you would like to make.

YOU damned sure can't justify them being treated the same or different, even if it does seem "reasonable". Perhaps Mark can explain something about market behavior which you and I do not yet know about...

Note, please, I'm not arguing in favor of slavishly following the edicts of "experts" -- but, particularly in an area like Economics, I'm not foolish enough to presume that the amount of study I've devoted to it can give me deep insights which are utterly at odds with that of Experts in the field. In the case which I might make an adamant statement about Economics against an expert in the field (such as "after the events of the 1970s, all Keynesians are idiots) it's more because I've listened to other, equally credentialed experts whose expressions are the basis for that statement -- not me reasoning from what I alone think to be obvious.

You don't cite a single reference. You may notice that a lot of people here link their statements when attrbutable to other sources. You rarely, if ever, do. You might have chased down a news item about each of the three cases you mentioned in passing... For all we know, you made those up out of whole cloth to support your claims.

I don't know you did that, but I've seen it happen often enough that I don't presume someone doesn't do that until I've seen evidence to the contrary. And since I've seen you make statements that were blatantly at odds with the reality of things, I don't presume even YOU are necessarily aware when you are inventing.

I think someone is trying to confuse the issue. The problem in oil is not said to be due to the futures market it is to do with hypothetical speculation. If there were onion futures, prices might be more stable. What does that have to do with whether or not speculators are influencing the price of oil?

Producers and distributers benefit from futures. What does that have to do with speculators?

I think the limited point Mark is trying to drive home is that the rapidly rising price of oil is not purely an artifact of it being a futures market. This is important because the Dems are using this unfortunate price increase to attack futures trading. It might be market manipulation, or a bubble, or Obama saying that he is going to slap a tax on U.S. oil producers (why doesn't anyone mention this as a potential cause of higher prices?), but none of those reasons depend on the fact it is a futures market.

"And yet even with no traders to blame, the volatility in onion prices makes the swings in oil and corn look tame, reinforcing academics' belief that futures trading diminishes extreme price swings."

This proves futures trading can artificially raise prices. It does so by diminishing extreme price swings. When it diminished extreme downward price swings it is keeping the prices up. A lot of people would like an extreme downward swing in the price of oil.

Futures markets (and speculators) likely dampen volatility. The Onion market is a good comparison without a futures contract, to Oil market with a futures contract. Perhaps Dodd-Frank should encourage speculators and futures market.